DB Principles Can Boost DC Effectiveness

Defined contribution plans have grown and proliferated, while the converse has been true for the defined benefit universe. That’s not secret. But what may be more unusual is the argument BNY Mellon makes in a recent paper that applying the principles of DB plan administration can benefit DC plans.

In “The DC Plan of the Future: DB Principles for the DC Generation,” BNY Mellon presents the results of research in which it sought insights regarding how organizations are responding to the shift from DB to DC plans and what best practices they are using to improve their retirement plans.

BNY Mellon says that the most common best practices they found are:

• leveraging institutional investment strategies;

• ensuring that education and automation work together; and

• pursuing greater transparency in the pricing model.

Institutionalization of Investments

The report says that DC plans often face the following challenges regarding investments:

• higher costs;

• limited access to alternative investments, limiting their ability to increase returns and reduce risk through diversification; and

• uncertain final benefit with participants bearing investment risk.

This, it says, is an area in which DC plans can benefit by borrowing best practices from DB plan administration. Following such an approach, it says, relies on:

• increased use of low-fee, institutional vehicles;

• greater use of alternative strategies; and

• generating an income stream during retirement.

Education and Automation

The report acknowledges the usefulness of automation in increasing participation and retirement savings; however, it notes that it is not a panacea.

The limitations of automation, the report says, are that it:

• has not ensured adequate savings rates;

• does not address participants’ unique circumstances; and

• fails to provide a post-retirement roadmap.

But much like chocolate and peanut butter, education can work in concert with automation and in the process ameliorate the limitations of the latter, the report argues.

And like automation, education serves a plan and its participants regardless of their ages and other demographic factors, and can mitigate those differences. “Even at similar income levels, participants of varying ages and tenure face different risks. Millennials have time on their side, and go into retirement planning with their eyes wide-open: they have never had a pension, and assume that the Social Security system will go bankrupt long before they retire. The bigger challenge lies with those between the ages of 50 to 60, many of whom grew up thinking that both the DB plan and Social Security would take care of them. For this age group, there are a lot of questions such as what to do with the money, how to access it, and what the fees are. Targeted communications to participants nearing retirement can highlight the fact that staying in the plan is a compelling option,” says the report.

Transparency

DC pricing models continue to evolve, BNY Mellon says. It argues that bundled pricing arrangements can limit transparency, increase costs, and create conflicts of interest. The report suggests that this is another area in which DC plans can benefit from DB plans’ experience and practices, noting that “sponsors are increasingly looking to overcome these challenges through unbundled pricing models and adopting buying behaviors just as they would in the DB world.”

DC Plan Evolution

“DC plans have become a critical component for retirement provision across the U.S.,” the report says, adding that while DC plans have made significant strides, “there remains work to be done if they are to improve retirement outcomes for the millions of Americans that they cover.” And one thing plan sponsors can consider to help in that process, it suggests, is to borrow from aspects of DB plans.